Commercial vs. Investment Banks

Did.

Yeah, I totally disagree with it. In fact, I would argue that if we would have repealed Glass-Steagall 20 years ago, this problem may not have occurred. I'll go back to what Barney Frank said: If all financial institutions would have behaved like the insured deposit institutions, this crisis would never have occurred.

Now, Barney Frank and I don't agree on a lot -- (laughs) -- on most things when it comes to financial services. We do agree on that. The investment banks were the big problems in this. And I don't even think Citicorp would have got into the problems it did. But it was competing with the investment banks. And it gets back to, our people are going to leave us if we don't do these things.

Now, again, I am not excusing the management. You still should be able to stand up and say: "I don't care if they leave us. We're not going to do it. This is wrong to do." But it's harder to do if you see some competitors out there making a lot of money, taking your people away.

And none of us know for sure if there's a bubble. I mean, this isn't 100 -- if it was 100 percent sure, it would never occur, right? So there is some risk. And I say we're always early. As it gets later in the cycle and it still hasn't happened, I must tell you that some members of my management were questioning whether this was the right thing to do.

So let me just tell you two things that really I think stunned me more than anything. This was a journey of revelation for me and my fellow commissioners. And there are two things that really stick out. And first, let me say, you know, I've been treasurer of the state of California; I had been in business for two decades, so I had been, in a sense, a user of the financial system. I thought I knew something about finance in this country.

I was struck by two phenomena, first of all, the extent to which our financial system had become a casino, not what it should be or what I thought it was, which was a place that deployed capital for an economy and the nation. I felt sometimes like I had walked into my local community bank, and I had opened the wrong door, and what I saw was a casino floor as big as New York, New York. And I was shocked. And, unlike Claude Rains in Casablanca, I was truly shocked at what I saw, the extent to which the big financial institutions of this country had thrived by taking enormous risk and trading, not by lending capital to grow the economy.

The second revelation for me was, again, not as someone who's politically naive -- I had run for governor of the state of California -- but I was taken aback at the raw exercise of power by the financial industry, the resources they could throw at any "problem," like our commission, the hired guns they hired, the toughness with which they approached what we were doing, which I saw as an important service for the country. And I was really taken aback at what I saw as a tremendous power being wielded without reservation. …

But even that, the only one that was big in this business that was a commercial bank was really Citicorp. Later on, Merrill Lynch merged with Bank of America. But this was after the crisis occurred.

So the other commercial banks, other than Citicorp, really were not huge into the process. In fact, even [ranking member of the House Financial Services Committee] Barney Frank [D-Mass.] said that if only deposit institutions, insured deposit institutions, if only those were involved, this crisis would never have occurred. It was outside of insured deposit institutions, or outside of the general commercial banking industry.

Well, apologized and then quickly recanted and began a very steady course of revisionism. But the fact is that it was ascribed to fairly broadly. Here is just kind of one piece of information. On the eve of the crisis by 2007, the shadow banking industry, which is essentially the lightly or not regulated parts of our financial markets, had grown to have about $13 trillion of assets. The traditional banking sector -- you know, the commercial banks and thrifts that were regulated for the public interest -- had about $11 trillion.

What had grown up alongside our traditional regulated banking sector was a largely unregulated financial system with many dark pockets unseen by the public and by regulators. And in the end it was the risk in those systems that overwhelmed the system itself. …

How do you know I was in that meeting?

OK. It's probably under public domain.

There was obviously a lot of debate about what has come to be known as the Volcker Rule. As a member of the President's Economic Recovery Advisory Board, one of the subcommittees was financial regulation. There were other subcommittees. I was on that subcommittee. I was also on the infrastructure subcommittee. There was an education subcommittee, an energy subcommittee.

And one of Paul's views [was] if you're going to have the full faith and credit of the government or be an institution -- he'll say it differently -- that's too big to fail, then you need to look at how you take your risks differently than the firms that don't have the backing of the government. Whether it's the ability to use a discount window, the Fed window or FDIC [Federal Deposit Insurance Corp.] insurance, whatever it may be, if you're one of those firms using the government to help support where you fund yourself, then there are certain products and services you should not be doing within the firm. And he was clear.

From where I sat, Paul was not going back to Glass-Steagall, so this was not going back to that type of scenario. What Paul's view was was really about the idea of principal risk, and it's fine to take principal risk if it's for your client, but if you're taking principal risk to compete against your client, well, why is that fair? And his view was -- and I'm sure when you interview Paul he'll say it differently -- but his view is these institutions are 25, 35 times levered, and the reason you can be levered so much is because of how you're viewed and the government support you get with the Fed window and the FDIC insurance., so where he'll say, "Hey, a hedge fund is 1.5 times levered, and why should you guys be in the same space when you can use your leverage differently?"

So Paul's view was that banks who were bank holding companies should not be able to be their own hedge fund and should not be a private equity fund. His other thing was why should firms go buy chemical companies or media companies when literally their space is in financial services? Why is that good for the client who you're supposed to be serving? And so I think there was a lot of debate. Certainly the debate has grown from there, but the debate was how should you use your principal risk? And if you're going to be in a delevering environment, shouldn't your principal risk be used for the client?

And I think that was the debate, and I understood Paul's perspective, because I'm in a firm that really doesn't do private equity, because our view was it was an inherent conflict with our clients, and on the hedge fund side I'm of the view we should give our best ideas to the clients.

Well, they really put all banks into this. There are 6,000 commercial banks, insured deposit banks. And add another few hundred for investment banks and S&Ls and so on. And again, about 20 of them sinned. And yet everyone's being equally vilified, demonized and, quite frankly, regulated for something they really didn't do.

Oh, I think, first of all, it's political. I think that's being done in Washington, D.C., by Congress and the politicians in Washington, D.C. And I think a lot of other people are just uninformed, and they're angry, and they're suffering. And they should be angry. And it's unfortunate that they're suffering. But I think they're putting the blame, a blanket blame that's, quite frankly, undeserved. In fact, those institutions that didn't participate in this lost market share, lost potential profitability during that period because they knew it was wrong and said, "We're not going to participate in it." I mean, they did the right thing, and they're being -- we've socialized the punishment and put it against everyone, when, again, about 20 institutions are the ones that really caused this.

And so I don't -- I mean, I blame them for not being informed, but I can certainly understand why they think it's everybody, because that's been the mantra coming out of Washington, D.C., and, quite frankly, the media. I don't know what happened to investigative journalism. The media has let people say things that are totally untrue and have not done a very good job of describing who is guilty and who is innocent. They just repeated what politicians and others have said.

Well, the financial services industry. It really [was] what people refer to as banks -- because, you know, investment banks. But what really it was, it was the noncommercial banks, or those that we call deposit institutions. It was investment banks, primarily, and savings and loan associations.

Look, in my view, banks can do the trading they want, but those kind of institutions shouldn't be backed up by the taxpayers of the United States. And they shouldn't be of a scale where they're too big to fail and systemically important that we have to ride to their rescue.

So it's fine if a financial institution wants to be a trading house. Let them take their risks. And if they win, they win. If they lose, they lose. But when you allow that to happen in the mega-financial institutions, and you couple that with a backing by the taxpayers of the United States, that's a formula for disaster. And unless we break that bond, we're going to have repeated crises.

You know, it's interesting. People on the right who have resisted many of the financial reforms point to Fannie Mae and Freddie Mac as deeply flawed business models. And they were. The profits were privatized; the losses were socialized. But the model of Freddie Mac and Fannie Mae that were so disastrous really ended up being the model for Wall Street, of the big institutions: profits privatized, losses socialized.

So, you know, some would argue that you need mega-financial institutions for us to compete in the global economy. I'm not so sure that's the case. Most big loans are syndicated. And, you know, we competed just fine in the global economy when we had more banks, more regional banks, more diversitye in their financial sector for years and years.

Oh, yeah. Banks were reformed after the Great Depression. They absolutely were. Glass-Steagall really did it. It was a political-will issue, and it continues to be. We can absolutely reform banks. We just have to care enough about it, and we have to trust that the world won't collapse in the meantime. But, I mean, we can also set that up.

What I keep saying is, we can't set up a perfect system, but we have to compare what we can set up to what already exists. And what already exists is dysfunctional. What we have is a bunch of "too big to fail" banks that are insolvent, currently. They're zombie banks. And same thing for Europe. Europe is a mess. And the question isn't, "Are we going to create something perfect?" The question is, "Are we going to create something better than this?" It's actually pretty low bar, so I think it's definitely achievable.

So one of the things we're working on is a Move Your Money app. So the idea is to make it really easy for people to move money from their big banks to credit unions. It's a great idea to do that, but there's a pretty big obstacle for most people, that they don't know credit unions that they're eligible for.

Credit unions have something they call the field of membership where you have to work someplace or live someplace or be a part of some union to actually be a member of their credit union. So the idea of the app is you will enter information into the app and it will give you a list of credit unions -- their locations, the ATMs nearby and their services, to make it easier for people to do that.